Three Years in Clean Energy: An Investing Lesson in Expectations

Remember clean energy? That surefire big winner from the global march toward “net zero” carbon emissions and a green future? Sure to generate big returns for investors who got in on the ground floor? Things the world will clamor for over decades to come? Things huge walls of cash are chasing, sure to push the stocks higher over the long run? If we had a nickel for every time we heard something along these lines over the last few years, we would have a considerable pizza fund. But for investors jumping on the bandwagon this decade, it isn’t working out well, illustrating the timeless importance of separating hype from reality, considering markets’ ability to pre-price widely known factors and remembering to diversify broadly.

First, to be clear, we have nothing against solar and wind power or any of the downstream aspects stemming from it. Maybe those high hopes will play out in time, and there are some good reasons to have some exposure now. But it is getting very hard to ignore the troubles in clean energy—mainly wind and solar—gaining headlines now. And it highlights how easy it was for the narrative of renewable energy to outpace the reality—a cautionary tale for interested investors.

News of canceled projects and asset write-downs due to high costs and dim prospects frequently feature in financial headlines. One gauge of stocks in the field, the S&P Global Clean Energy Index, is down more than -40% year to date, defying broader markets’ overall rally from last October’s lows (the recent correction notwithstanding).^[i] But problems predate 2022. The index had a monster 2020, seemingly buoyed by hopes for big green energy subsidies from a new US presidential administration and European governments. Those subsidies arrived. But markets pre-priced them in advance and have been sour since: The S&P Global Clean Energy Index peaked on January 13, 2021 and is down -58.2% from the high.^[ii] So not only did it slide during this young bull market, but it participated in 2022’s bear and started tumbling around a year before global stocks did—and to a much greater extent. Most of 2020’s boom is now erased.

Naturally, this raises the question of why. Why are these big political winners not investment winners? Well, we see a lot of reasons. One, there is a lot of NIMBY-ism. Turns out that many people like windfarms on paper but find them a noisy, landscape-blighting, bird-killing nuisance in real life. Offshore wind, too, generates resistance as more people become aware of its impact on marine life.

Two, and more pertinently, the costs very often don’t add up. Turbines and large-scale solar plants are resource-intensive, requiring mountains of plastic (ironically made from petrochemicals), metals and steel to produce. Much of this raw material supply comes from China, exposing producers to shortages and other headaches as pandemic-related disruptions rippled. Even with subsidies, wind and solar power is expensive to generate at scale, driving electricity providers away. Lastly—and relatedly—the wind doesn’t always blow, and the sun doesn’t always shine. This creates big problems in winter, especially in Europe, which is prone to long cold, windless stretches called dunkelflaute. The estimated cost of electricity storage to bridge these gaps is astronomical, and then there is the matter of how to store it.^[iii] Lithium-ion batteries are also resource-intensive and come with concerns about materials sourcing.

No wonder, then, that attention is shifting to other energy alternatives including next-generation nuclear reactors, hydrogen and synthetic fuels (which markets have already priced in, too, based on returns for some of the companies associated with these). Meanwhile, the wind landscape is not pretty. A September UK government auction of windfarm licenses attracted zero bids—all potential players said the minimum wind power price offered was far too low to generate profits. This week, a leading Danish wind farm developer canceled a big planned project off the New Jersey coast and wrote off $4 billion worth of assets, while one of Britain’s biggest energy firms wrote down the value of a big New York project.^[iv]

None of these problems are new or surprising, but there is a simple reason they are coming to a head now: High borrowing costs. Conventional wisdom says Tech is most vulnerable on this front since investors traditionally pay big multiples now for future earnings. But Tech, especially big Tech, is actually pretty immune since most companies have locked in debt at low rates, finance investment with earnings and have cash-rich balance sheets—which now generate higher returns thanks to higher rates. Clean energy, on the other hand, is more debt-reliant, so higher borrowing costs compound longer-running headwinds. For many CEOs, it is all increasingly hard to justify.

We often say markets move most on expected events over the next 3 – 30 months, with anything beyond that too far out to assess rationally. You can guess at the far future, but you can’t assign probabilities to it. In our view, clean energy returns are a shining example. Talk of net zero by 2030, 2035 or whenever fuels headlines and attracts political donations and votes. And at times, that talk has fueled speculation on Wall Street. But for nearly three years now, markets have apparently been pricing in all manner of nearer-term problems that throw the long-term future in doubt. And, furthermore, those far-flung goals are super widely known. As an investment thesis, ideas bandied about by most of the world’s governments, several supranational organizations and many think-tanks are very likely pre-priced—mitigating their ability to sway stocks looking forward. 

It is all too easy to let yourself get seduced by the prospect of reaping big riches from long-term, big change-type themes. And if you want to take part, don’t let us stop you. But from a investment standpoint—one with most people’s long-term goals and needs in mind—it is wisest to be very measured about such forays. Diversify. Doing otherwise is speculation. We think it is much wiser to remember investing is a long-term endeavor where diversification and risk management are crucial. Rational probabilities are a much stronger foundation than flashy narratives.